A recovery? Small businesses aren't so sure.

ByMary Helen Miller, CorrespondentJuly 19, 2011

In this July 15, 2011 photo, Newport Tent employee Ronnie Edelen uses a gasoline-powered "Ponjaur" hammer to drive the corner stakes for a 40x60 foot wedding tent at Sweet Berry Farm in Middletown, R.I. Owners of small businesses, the backbone of the Rhode Island economy, say burdensome rules and regulations cost them time and money. The gloomy outlook is widespread among small businesses nationwide.

Small business is sour, pessimistic. If America were holding a party to celebrate the recovery, small business would be the killjoy.

"It's a phony recovery," says Frank Shannon, owner of Finishes Ltd., in Colorado Springs, Colo. A decade ago, his small metal-plating company employed more than 20 people. Today, his workforce is fewer than 10. "If I don't have orders, I don't need employees," he says.

The gloom is widespread. Small-business optimism has been sinking since March, says the National Federation of Independent Business (NFIB), a Washington-based group that represents small businesses and surveys them monthly. Its May poll of more than 700 small businesses found that more small firms are planning to shrink their payroll this summer than expand it.

It's not clear whether all this pessimism is justified. But the danger is that it becomes self-fulfilling, observers say. If small-business owners are not optimistic about sales, they won't stock more goods and hire people who can keep the economy's engine running. How much does the performance of small businesses matter to economic recovery?

Small businesses represent a big chunk of the US economy. Firms with fewer than 50 workers employ slightly more than a quarter of America's workforce. If one counts as a small business any firm with fewer than 500 employees, the sector balloons to half of America's workers. Counted that way, small business also accounts for about half of economic activity, as measured by gross domestic product.

"If you're talking about half the economy, and sales growth isn't there, and job growth isn't there, it's a pretty significant effect," says Dane Stangler, a director of research at Kauffman. "There are lots of reasons for pessimism."

But even though small business has much to overcome, data show that firms with fewer than 50 employees have fared better than larger ones since the recession began. Employment at the smallest businesses – those with fewer than 50 employees – fell less during the Great Recession than it did at larger businesses, and it has rebounded faster, according to surveys of the private sector by payroll processor ADP. Since hitting a low in 2010, small-business employment has risen 1.7 percent, a little better than the 1.4 percent of larger business. As a result, the small-business workforce is only about 4 percent below its prerecession peak, while employment at larger businesses is still off 7 percent.

Entrepreneurs are also starting new businesses at a record pace, according to the Kauffman Foundation, which has been tracking entrepreneurship for 15 years.

But entrepreneurship isn't enough on its own; new businesses will need to hire other employees to have any real impact on the economy. It is new, expanding businesses that historically have generated anywhere from 50 to 80 percent of job growth in the United States.

"The jobs recovery is not going to be built on the back of the Fortune 1000," says Mr. Litan. "If and when we get a recovery, it's going to be built on the backs of new businesses."

Some companies are doing well, he adds, among them those building the next generation of Web software. Plus, with access to cloud computing, the cost of starting a business continues to fall, says Mr. Stangler. "It certainly hasn't risen."

On the other side of the scale, small businesses have a list of worries that weren't factors during past economic recoveries. Financing is one of them. Small businesses rely more heavily on banks than larger businesses do, and since banks tightened lending standards during the recession, they've had less access to credit. Small businesses also depend more on owners' personal capital, which may have dried up in the housing or stock market.

And small-business owners are wringing their hands over how new health-care and tax policies could affect them.

"It's another reason why you're a little concerned with increasing your employment significantly," says David Painter, owner of Painter Tool, a government contractor in North Huntingdon, Pa. Mr. Painter, who manufactures parts for military machinery, has actually seen business increase overall since 2007. But rather than hiring, he's adding contractors.

"By contracting out, we've found it more efficient in some ways," he says. "No matter who you contract [the work] to, you only pay for the good parts you buy."

A year ago, Mr. Vargo was helping many small-business owners decide whether to shut down. Now, many small-business owners are looking to expand. "Find people who are willing to move on," he says he tells entrepreneurs who do business with other companies.

Even if those businesses that want to expand are still struggling to make payments, it might be worth sticking with them, he adds. "Be more patient with that customer, because down the road it could be a huge success."